The IRS has postponed the federal tax filing and payment deadlines, and associated interest, penalties, and additions to tax, for certain taxpayers who have been adversely affected by the Coronavirus Disease 2019 (COVID-19) pandemic. 

The IRS has postponed the federal tax filing and payment deadlines, and associated interest, penalties, and additions to tax, for certain taxpayers who have been adversely affected by the Coronavirus Disease 2019 (COVID-19) pandemic. For individual taxpayers, the notice postpones to May 17, 2021, certain deadlines that would normally fall on April 15, 2021, such as the time for making IRA contributions and for filing federal income tax refund claims. The notice also extends the time for return preparers to participate in the Annual Filing Season Program for the 2021 calendar year.

The IRS has released this notice as a follow-up to a previous announcement on March 17 that the federal income tax filing due date for individuals for the 2020 tax year was extended from April 15, 2021, to May 17, 2021. This notice provides details on the additional tax deadlines which have been postponed until May 17.

Federal Tax Returns and Tax Payments
For an affected taxpayer, the due date for filing federal income tax returns in the Form 1040 series having an original due date of April 15, 2021, and for making federal income tax payments in connection with one of these forms, is automatically postponed to May 17, 2021. Affected taxpayers do not have to file any form, including Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, to obtain this relief.

This relief includes the filing of all schedules, returns, and other forms that are filed as attachments to the Form 1040 series, or are required to be filed by the due date of the Form 1040 series, including, for example, Schedule H, Household Employment Taxes, and Schedule SE, Self-Employment Tax, as well as:

• Form 965-A (Individual Report of Net 965 Tax Liability);
• Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts);
• Form 5329 (Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts);
• Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations);
• Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund);
• Form 8858 (Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs));
• Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships);
• Form 8915-E (Qualified 2020 Disaster Retirement Plan Distributions and Repayments); and
• Form 8938 (Statement of Specified Foreign Financial Assets).

Additionally, elections that are made or required to be made on a timely filed Form 1040 series (or attachment to such form) will be timely made if filed on such form or attachment, as appropriate, on or before May 17, 2021.

Claims for Refund
Individuals with a period of limitations to file a claim for credit or refund of federal income tax expiring on or after April 15, 2021, and before May 17, 2021, have until May 17, 2021, to file those claims for credit or refund. This postponement is limited to claims for credit or refund properly filed on the Form 1040 series or on a Form 1040-X. As a result of this postponement, the period beginning on April 15, 2021, and ending on May 17, 2021, will be disregarded in determining whether the filing of those claims is timely.

IRA and HSA Contributions
The postponement also automatically postpones to May 17, 2021, the time for affected taxpayers to make 2020 contributions to their individual retirement arrangements (IRAs and Roth IRAs), health savings accounts (HSAs), Archer Medical Savings Accounts (Archer MSAs), and Coverdell education savings accounts (Coverdell ESAs). It also automatically postpones to May 17, 2021, the time for reporting and payment of the 10-percent additional tax on amounts includible in gross income from 2020 distributions from IRAs or workplace-based retirement plans.

For affected taxpayers that must file forms in the Form 5498 series, the due date for filing and furnishing the Form 5498 series is postponed to June 30, 2021. The period beginning on the original due date of those forms and ending on June 30, 2021, will be disregarded in the calculation of any penalty for failure to file those forms.

Estimated Tax Payments, Other Items Not Extended
The postponement also automatically postpones to May 17, 2021, the time for affected taxpayers to make 2020 contributions to their individual retirement arrangements (IRAs and Roth IRAs), health savings accounts (HSAs), Archer Medical Savings Accounts (Archer MSAs), and Coverdell education savings accounts (Coverdell ESAs). It also automatically postpones to May 17, 2021, the time for reporting and payment of the 10-percent additional tax on amounts includible in gross income from 2020 distributions from IRAs or workplace-based retirement plans.

The IRS has provided guidance related to the temporary 100-percent deduction for business meals provided by a restaurant. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 ( P.L. 116-260) temporarily increased the deduction from 50 percent to 100 percent for a business’s restaurant food and beverage expenses for 2021 and 2022. All other food and beverage expenses are still subject to the 50 percent deduction limitation unless some other exception applies.

The IRS has provided guidance related to the temporary 100-percent deduction for business meals provided by a restaurant. The Taxpayer Certainty and Disaster Tax Relief Act of 2020 ( P.L. 116-260) temporarily increased the deduction from 50 percent to 100 percent for a business’s restaurant food and beverage expenses for 2021 and 2022. All other food and beverage expenses are still subject to the 50 percent deduction limitation unless some other exception applies.

Restaurants Defined
According to the IRS’s guidance, a restaurant is a business that prepares and sells food or beverages to retail customers for immediate consumption. Note that the food and beverages do not need to be consumed on the premises for the 100-percent deduction to apply.

Restaurants are not businesses that predominantly sell pre-packaged food or beverages that are intended for later consumption. Food or beverages purchased from such businesses are still subject to the 50-percent deduction limitation. Examples of businesses that are not restaurants include grocery stores, specialty food stores, liquor stores, drug stores, convenience stores, newsstands, vending machines, or kiosks.

Restaurants are also not eating facilities located at an employer’s business that provide meals that are excluded from the employees’ gross income under Code Sec. 119, or that are considered a de minimis fringe under Code Sec. 132(e)(2). This also applies to eating facilities on the employer’s premises that are operated by a third party with regards to Reg. §1.132-7(a)(3).

Effective Date
This IRS guidance is effective for food and beverages purchases made after December 31, 2020, and before January 1, 2023.

The IRS has issued guidance for employers claiming the employee retention credit under Act Sec. 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) ( P.L. 116-136), as modified by Act Secs. 206 and 207 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act) (Division EE of P.L. 116-260), for the first and second calendar quarters in 2021. The guidance amplifies previous guidance which addressed amendments made by section 206 of the Relief Act for calendar quarters in 2020.

The IRS has issued guidance for employers claiming the employee retention credit under Act Sec. 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) ( P.L. 116-136), as modified by Act Secs. 206 and 207 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act) (Division EE of P.L. 116-260), for the first and second calendar quarters in 2021. The guidance amplifies previous guidance which addressed amendments made by section 206 of the Relief Act for calendar quarters in 2020.

In general, eligible employers can claim a refundable employee retention credit against the employer share of Social Security tax equal to 70 percent of the qualified wages they pay to employees after December 31, 2020, through June 30, 2021. Qualified wages are limited to $10,000 per employee per calendar quarter in 2021. Thus, the maximum employee retention credit available is $7,000 per employee per calendar quarter, for a total of $14,000 for the first two calendar quarters of 2021.

For calendar quarters beginning after 2020, an employer is generally eligible for the credit if it was carrying on a trade or business during the calendar quarter for which the credit is determined, and either (1) had operations that were fully or partially suspended during the calendar quarter due to governmental orders limiting commerce, travel, or group meetings due to COVID-19, or (2) experienced a decline in gross receipts for the calendar quarter when compared to the same quarter in 2019.

The guidance explains changes made to the employee retention credit for the first two calendar quarters of 2021, including:

• the increase in the maximum credit amount,
• the expansion of the types of employers that may be eligible to claim the credit,
• modifications to the gross receipts test,
• revisions to the definition of qualified wages, and
• new restrictions on the ability of eligible employers to request an advance payment of the credit.

The guidance does not address the employee retention credit provided by Code Sec. 3134, enacted by the American Rescue Plan Act of 2021 ( P.L. 117-2), for wages paid after June 30, 2021, and before January 1, 2022. The IRS will address Code Sec. 3134 in future guidance.

Highlights of some of the items addressed in the guidance are summarized below.

Eligible Employers
While the employee retention credit is not available to most governmental employers, it is available to tax-exempt organizations described in Code Sec. 501(c)(1), and to any governmental entity that is a college or university or whose principal purpose is providing medical or hospital care. For this purpose, a college or university means an educational organization as defined in Code Sec. 170(b)(1)(A)(ii) and Reg. §1.170A-9(c)(1). An entity that has the principal purpose or function of providing medical or hospital care means an entity that has the principal purpose or function of providing medical or hospital care within the meaning of Code Sec. 170(b)(1)(A)(iii) and Reg. §1.170A-9(d)(1).

Decline in Gross Receipts
One way an employer can be eligible for the credit is if it experienced a decline in gross receipts. Whether an employer is an eligible employer based on a decline in gross receipts is determined separately for each calendar quarter, and is based on an 80 percent threshold compared to the same calendar quarter in 2019.

If an employer did not exist as of the beginning of the first calendar quarter of 2019, the employer generally determines whether the decline in gross receipts test is met in the first calendar quarter of 2021 by comparing its gross receipts in that quarter of 2021 to its gross receipts in the first calendar quarter of 2020. If an employer did not exist as of the beginning of the second calendar quarter of 2019, the employer generally determines whether the test is met in the second calendar quarter of 2021 by comparing its gross receipts in that quarter of 2021 to its gross receipts in the second calendar quarter of 2020. An employer may also elect to use an alternative quarter to calculate gross receipts.

Eligible employers must maintain documentation to support the determination of the decline in gross receipts, including which calendar quarter an eligible employer elects to use in measuring the decline.

Qualified Wages
Whether wage payments by an eligible employer will be considered qualified wages depend, in part, on the average number of full-time employees an eligible employer employed during 2019. For the first and second calendar quarters of 2021, large eligible employers are those whose average number of full-time employees during 2019 was greater than 500. For these employers, qualified wages are wages paid to an employee for time that the employee is not working for the reasons the credit is allowed.

Small eligible employers are those whose average number of full-time employees during 2019 was 500 or less. For these employers, qualified wages are the wages paid an employee whether the employee is working or not working for the reasons the credit is allowed.

An employer may not claim a credit under Code Secs. 41, 45A, 45P, 45S, 51, or 1396 with qualified wages for which it claims the employee retention credit, but it may be able to take a credit under these provisions for wages for which it did not claim an employee retention credit if the particular credit’s requirements are met.

Claiming the Credit
Eligible employers may continue to access the employee retention credit for the first and second calendar quarters of 2021 prior to filing their employment tax returns by reducing employment tax deposits in anticipation of the credit. However, advance payment of the employee retention credit is available only to small eligible employers, who can may elect to receive an advance payment of not more than 70 percent of the average quarterly wages paid in calendar year 2019.

For this purpose, average quarterly wages generally means the average of wages or compensation determined without regard to the social security wage base, paid in each calendar quarter in 2019. The guidance provides details for calculating average quarterly wages. Small eligible employers that come into existence in 2021 are ineligible to receive advance payment.

Effect on Other Documents
Notice 2021-20, I.R.B. 2021-11, 922, is amplified.

The IRS has issued guidance clarifying that amounts paid for personal protective equipment—such as masks, hand sanitizer and sanitizing wipes—for the primary purpose of preventing the spread of the Coronavirus Disease 2019 (COVID-19 PPE) are treated as amounts paid for medical care under Code Sec. 213(d).

The IRS has issued guidance clarifying that amounts paid for personal protective equipment—such as masks, hand sanitizer and sanitizing wipes—for the primary purpose of preventing the spread of the Coronavirus Disease 2019 (COVID-19 PPE) are treated as amounts paid for medical care under Code Sec. 213(d).

Therefore, amounts paid by an individual taxpayer for COVID-19 PPE for use by the taxpayer, the taxpayer’s spouse, or the taxpayer’s dependent(s) that are not compensated for, by insurance or otherwise, are deductible under Code Sec. 213(a) if the taxpayer’s total medical expenses exceed 7.5 percent of adjusted gross income.

Since amounts paid for COVID-19 PPE are medical care expenses under Code Sec. 213(d), they are also eligible to be paid or reimbursed under:

• health flexible spending arrangements (health FSAs),
• Archer medical savings accounts (Archer MSAs),
• health reimbursement arrangements (HRAs), or
• health savings accounts (HSAs).

Note, however, that amounts paid or reimbursed under one of these arrangements or accounts are not deductible under Code Sec. 213.

Group Health Plans
If COVID-19 PPE expenses may not be reimbursed under the terms of a group health plan (including a health FSA and an HRA), the plan can be amended under this IRS guidance to provide for reimbursements of expenses for COVID-19 PPE incurred for any period beginning on or after January 1, 2020. Such an amendment will not be treated as causing a failure of any reimbursement to be excludable from income under Code Sec. 105(b), or as causing a cafeteria plan to fail to meet the requirements of Code Sec. 125.

Group health plans can be amended under this IRS guidance if:

• the amendment is adopted no later than the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective,
• no amendment with retroactive effect is adopted after December 31, 2022, and
• the plan is operated consistent with the terms of the amendment, including during the period beginning on the effective date of the amendment through the date the amendment is adopted.

The U.S. Department of Labor has published a new webpage with guidance implementing the Continuation of Health Coverage premium assistance provisions of the American Rescue Plan (ARP), to provide full COBRA premium assistance to certain individuals who experienced a reduction in hours or involuntary termination of employment.

The U.S. Department of Labor has published a new webpage with guidance implementing the Continuation of Health Coverage premium assistance provisions of the American Rescue Plan (ARP), to provide full COBRA premium assistance to certain individuals who experienced a reduction in hours or involuntary termination of employment. This guidance, from the Labor Department’s Employee Benefits Security Administration, includes documents to implement these provisions, such as FAQs about COBRA premium assistance, FAQs on COBRA continuation health coverage for workers, and model notices.

COBRA Premium Subsidy
COBRA allows employees and their families who would otherwise lose their group health coverage due to certain life events to continue their group health coverage, known as COBRA continuation coverage. The ARP provides a 100 percent premium subsidy between April 1, 2021 and Sept. 30, 2021, for individuals whose reduction in hours or involuntary termination of employment makes them eligible for COBRA continuation coverage during this period. The ARP also requires group health plans to provide notices to individuals losing health coverage to inform them about premium assistance that may be available to them.

The IRS has announced that, under the American Rescue Plan Act of 2021 (ARP) ( P.L. 117-2), the requirement that taxpayers increase their tax liability by all or a portion of their excess advance payments of the Premium Tax Credit (excess APTC) is suspended for tax year (TY) 2020.

The IRS has announced that, under the American Rescue Plan Act of 2021 (ARP) ( P.L. 117-2), the requirement that taxpayers increase their tax liability by all or a portion of their excess advance payments of the Premium Tax Credit (excess APTC) is suspended for tax year (TY) 2020. A taxpayer’s excess APTC is the amount by which the taxpayer’s advance payments of the Premium Tax Credit (APTC) exceed his or her Premium Tax Credit (PTC). Eligible taxpayers with excess APTC for 2020 are not required to file Form 8962, Premium Tax Credit, or report an excess advance Premium Tax Credit repayment on their 2020 Form 1040 or Form 1040-SR when they file. Taxpayers claiming a net PTC must file Form 8962 when they file their TY 2020 return.

Taxpayers who have already filed their TY 2020 return and who have excess APTC do not need to file an amended tax return or contact the IRS. Taxpayers who enrolled, or enrolled a family member, in health insurance coverage for TY 2020 through the marketplace should have received Form 1095-A, Health Insurance Marketplace Statement, from the marketplace. Taxpayers can check with their tax professional or use tax software to figure the amount of allowable PTC and reconcile it with their APTC received using the information from Form 1095-A.

The Premium Tax Credit helps pay for health insurance coverage bought from the health insurance marketplace. If the taxpayer’s PTC computed on the return is more than the APTC paid on the taxpayer’s behalf during the year, the difference is a net PTC.

The IRS has extended the penalty relief provided in Notice 2020-22, I.R.B. 2020-17, 664, for failure to deposit employment taxes, to eligible employers that reduce their required deposits in anticipation of the following credits.

The IRS has extended the penalty relief provided in Notice 2020-22, I.R.B. 2020-17, 664, for failure to deposit employment taxes, to eligible employers that reduce their required deposits in anticipation of the following credits:

• the paid sick and family leave credits under the Families First Coronavirus Response Act (Families First Act) ( P.L. 116-127), as amended by the COVID-related Tax Relief Act of 2020 (Tax Relief Act) (Division N of P.L. 116-260), for qualified leave wages paid with respect to the period beginning January 1, 2021, and ending March 31, 2021;
• the paid sick and family leave credits under Code Secs. 3131, 3132, and 3133, added by the American Rescue Plan Act of 2021 (ARP) ( P.L. 117-2), for qualified leave wages paid with respect to the period beginning April 1, 2021, and ending September 30, 2021;
• the employee retention credit under section 2301 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) ( P.L. 116-136), as amended by the Taxpayer Certainty and Disaster Tax Relief Act of 2020 (Relief Act) (Division EE of P.L. 116-260), for qualified wages paid with respect to the period beginning January 1, 2021, and ending June 30, 2021;
• the employee retention credit under Code Sec. 3134, added by ARP, for qualified wages paid with respect to the period beginning July 1, 2021, and ending December 31, 2021; and
• the COBRA Continuation Coverage Premium Assistance credit under Code Sec. 6432, added by ARP, for continuation coverage premiums not paid by assistance eligible individuals under section 9501(a)(1) of the ARP, during the period beginning April 1, 2021, and ending September 30, 2021.

Background
Eligible employers claim the paid sick and family leave credits under the Families First Act, and the employee retention credit under the CARES Act, against the employer’s share of the Old Age, Survivors, and Disability Insurance (Social Security) portion of FICA tax under Code Sec. 3111(a). Employers that are eligible for the paid sick and family leave credits under Code Secs. 3131, 3132, and 3133, the employee retention credit under Code Sec. 3134, or the COBRA Continuation Coverage credit under Code Sec. 6432, can claim the credit(s) against the employer’s share of the Hospital Insurance (Medicare) portion of FICA tax under Code Sec. 3111(b). The credits are also available to eligible railroad employers for the attributable Railroad Retirement Tax Act (RRTA) taxes under Code Sec. 3221(a).

These refundable tax credits are reported on the employer’s employment tax return for reporting its FICA tax liability, which for most employers is the quarterly Form 941. Certain employers may claim an advance payment of the refundable credits by filing Form 7200, Advance Payment of Employer Credits Due to COVID-19.

Code Sec. 6656 imposes a penalty for failure to timely deposit required tax amounts, unless the failure is due to reasonable cause and not willful neglect. Failure to deposit employment taxes required under Code Sec. 6302 generally subjects an employer to the penalty. The various legislative acts and provisions implementing the refundable employment tax credits described above either instruct the IRS to waive the penalty or authorize guidance that provides penalty relief.

Paid Leave Credit Penalty Relief
An employer can reduce an employment tax deposit for a calendar quarter without a penalty, by the amount of the applicable paid sick or family leave credit anticipated for the calendar quarter prior to the required deposit, as long as:

• the employer paid qualified leave wages, qualified health plan expenses, or qualified collectively bargained contributions, for the period beginning on April 1, 2021, and ending on September 30, 2021, to its employees in the calendar quarter prior to the time of the required deposit,
• the amount of employment taxes that the employer does not timely deposit is less than or equal to its anticipated applicable paid leave credits claimed for the calendar quarter as of the time of the required deposit, and
• the employer did not seek payment of an advance credit by filing Form 7200 for the anticipated credits it relied upon to reduce its deposits.

The total amount of the deposit reduction cannot be more than the total amount of the employer’s anticipated paid leave credits as of the time of the required deposit, minus any amount of those anticipated credits that had previously been used (1) to reduce a prior required deposit in the calendar quarter and obtain this relief or (2) to seek payment of an advance credit.

Employee Retention Credit Penalty Relief
After a reduction, if any, of an employment tax deposit by the amount of the anticipated paid sick or family leave credits, an employer may further reduce an employment tax deposit for a calendar quarter without a penalty, by the amount of its applicable employee retention credit anticipated for the calendar quarter prior to the required deposit, as long as:

• the employer paid qualified retention wages for the period beginning January 1, 2021 and ending December 31, 2021, to its employees in the calendar quarter prior to the time of the required deposit,
• the amount of employment taxes that the employer does not timely deposit— reduced by the amount of employment taxes not deposited in anticipation of the paid leave credits claimed— is less than or equal to the amount of the employer’s anticipated applicable employee retention credits for the calendar quarter as of the time of the required deposit, and
• the employer did not seek payment of an advance credit by filing Form 7200 for the anticipated credits it relied upon to reduce its deposits.

The total amount of any deposit reduction cannot be more than the total amount of the employer’s anticipated employee retention credit as of the time of the required deposit, minus any amount of the anticipated credit that had previously been used (1) to reduce a prior required deposit in the calendar quarter and obtain this relief or (2) to seek payment of an advance credit.

COBRA Credit Penalty Relief
After a reduction, if any, of an employment tax deposit by the amount of the anticipated paid sick or family leave credits and the anticipated employee retention credit, an employer may further reduce an employment tax deposit for a calendar quarter without a penalty, by the amount of the employer’s COBRA continuation coverage credit anticipated for the calendar quarter prior to the required deposit, as long as:

• the employer is a “person to whom premiums are payable,”
• the amount of employment taxes that the employer does not timely deposit— reduced by the amount of employment taxes not deposited in anticipation of the paid leave credits and the employee retention credits claimed—is less than or equal to the amount of the employer’s anticipated credits under Code Sec. 6432 for the calendar quarter as of the time of the required deposit, and
• the employer did not seek payment of an advance credit by filing Form 7200 for the anticipated credits it relied upon to reduce its deposits.

The total amount of any deposit reduction cannot be more than the total amount of the employer’s anticipated COBRA continuation coverage credit as of the time of the required deposit, minus any amount of the anticipated credit that had previously been used (1) to reduce a prior required deposit in the calendar quarter and obtain this relief or (2) to seek payment of an advance credit.

Effect on Other Documents
Notice 2020-22, I.R.B. 2020-17, 664, is amplified.

Continuing an ongoing effort to help those experiencing homelessness during the pandemic, the IRS has reminded people who do not have a permanent address or a bank account that may still qualify for Economic Impact Payments (EIP) and other tax benefits.

Continuing an ongoing effort to help those experiencing homelessness during the pandemic, the IRS has reminded people who do not have a permanent address or a bank account that may still qualify for Economic Impact Payments (EIP) and other tax benefits.

While EIPs are made automatically to most people, payments cannot be issued to eligible Americans when there is no information available in the tax agency’s systems. For this reason, the IRS urges employers and others to share information about EIPs and encourage the rural poor and other historically under-served groups to file returns so they can receive the benefits they are entitled to.

Individuals who do not normally file tax returns should nevertheless file a basic 2020 tax return with the IRS. Returns can be filed for free using the Free File tool available on IRS.gov. Once the return is processed, the IRS can send stimulus payments to an address that is selected by the eligible individual. Importantly, people do not need a permanent address, bank account, or a job. Payments are issued to eligible individuals even if the person has not filed returns in years.

Individuals in this category can still qualify for the first two EIPs when they file their 2020 return by claiming recovery rebate credit. For the current round of payments, individuals who are experiencing homelessness may qualify to receive $1,400 for themselves. If they are married or have dependents, they can get an additional $1,400 for each of their family members.

In addition, some eligible workers experiencing homelessness may qualify for Earned Income Tax Credit (EITC). To be eligible, the worker must have lived in the U.S. for more than half of the year and meet other requirements. For 2020, the income limit is $15,820 for individuals with no children, and $21,710 for couples with no children.

If individuals want to receive their payments through direct deposit, many financial institutions are helping them open a low-cost or no-cost bank account. Those that open accounts will then have an account and routing number available when they claim a direct deposit of their EIP. Those with a prepaid debit card may be able to have their refund applied to the card.

Death benefits that an S corporation provided to its sole shareholder under a split-dollar life insurance arrangement were employee compensation rather than a corporate distribution. In reaching this decision, the Tax Court firmly rejected the contrary conclusion reached by the Sixth Circuit Court of Appeals in J.J. Machacek, CA-6, 2018-2 U.S.T.C. 50,447.

Death benefits that an S corporation provided to its sole shareholder under a split-dollar life insurance arrangement were employee compensation rather than a corporate distribution. In reaching this decision, the Tax Court firmly rejected the contrary conclusion reached by the Sixth Circuit Court of Appeals in J.J. Machacek, CA-6, 2018-2 U.S.T.C. 50,447.

Background
The taxpayers were a medical doctor and his wife. The doctor was the sole owner of his practice, which was organized as an S corporation that employed him and his wife. The taxpayers received wages from the S corporation, as well as fringe benefits from an employee welfare benefit plan.

The fringe benefits included death benefits that the Tax Court had previously concluded were provided under a compensatory split-dollar life insurance program ( R. De Los Santos, Dec. 61.270). However. the taxpayers responded by seeking summary judgment that the economic benefits provided by the program actually constituted a corporate distribution.

Tax Court Rejects Machacek
In Machacek, the Sixth Circuit had relied on Reg. §1.301-1(q), which states that economic benefits that a corporation provides to a shareholder under a split-dollar life insurance policy are treated as distributions of property. The Sixth Circuit emphasized that the regulation’s cross reference to Reg. §1.61-22(b) meant that it applied to both compensatory and noncompensatory split-dollar arrangements.

The Tax Court rejected this analysis. Instead, it determined that Code Sec. 301 clearly requires distributions to be made to a shareholder in the shareholder’s capacity as a shareholder. Because the compensatory split-dollar life insurance arrangement afforded benefits to the doctor in his capacity as an employee of the S corporation, the Tax Court concluded that the economic benefits he received under the arrangement could not be characterized as “distributions” under Code Sec. 301.

S Corporation Fringe Benefits
The benefits also were fringe benefits paid by an S corporation under Code Sec. 1372. As such, they were treated as guaranteed partnership payments that were ordinary income, and not a corporate distribution.

The termination date for an empowerment zone designation under Code Sec. 1391 is generally deemed to extend until December 31, 2025. However, the state or local government that nominated the zone may decline the deemed extension.

The termination date for an empowerment zone designation under Code Sec. 1391 is generally deemed to extend until December 31, 2025. However, the state or local government that nominated the zone may decline the deemed extension.

Empowerment Zone Designation Termination Dates
Empowerment zone designations generally continue until the termination date selected by the government that nominated the zone (the designated termination date), or the termination date established by legislation (the statutory termination date).

The statutory termination date has been extended multiple times, with each extension deemed to extend the designated termination date as well. Most recently, the Taxpayer Certainty and Disaster Tax Relief Act of 2020 ( P.L. 116-260) extended the statutory termination date to December 31, 2025. Thus, the designated termination dates for all empowerment zones are also deemed to be extended to December 31 2025.

A state or local government may decline the extension via a written notification to the IRS by May 25, 2021. The notification must be faxed to Bruce Chang, CC:ITA:B07, at (855) 576-2341.

Rev. Proc. 2020-16, I.R.B. 2020-27, 10, is obsoleted for tax years beginning after 2020.

Taxpayers will experience a short delay to the start of the 2014 filing season, but passage of the Bipartisan Budget Act of 2013 averted the possibility of an IRS shutdown in January. The budget agreement, however, did not include any tax provisions, and tax reform must find a new vehicle to move forward in Congress. Meanwhile, the IRS starts 2014 with a new leader, who promised to restore public trust in the agency after a troubled 2013.

2014 filing season

To end the October government shutdown, Congress passed a stop-gap funding bill to keep the IRS and other federal agencies open through mid-January 2014. Many tax professional groups warned that a government shutdown in January, even for a few days, would result in significant delays in tax return processing and refunds. The Bipartisan Budget Act of 2013 authorizes funding for the federal government for two years.

The start of the 2014 filing season, however, will be slightly delayed because of the October shutdown. The IRS needs additional time to reprogram its return processing systems. The original start date of the 2014 filing season was January 21, 2014. In December, the IRS announced that the 2014 filing season will start on January 31. The IRS will not process any returns (electronic or paper) before January 31, 2014.

Most business filers can begin filing 2013 returns on January 13, the IRS reported. These include filers of Forms 1120, U.S. Corporation Income Tax Return; 1120S, U.S. Income Tax Return for an S Corporation; and 1065, U.S. Return of Partnership Income. However, the January 13 start date does not apply to business owners that report their incomes on Form 1040. They must wait until January 31.

Tax legislation

Many tax reform proposals were introduced in Congress in 2013 but lawmakers deferred action until 2014. The leaders of the House and Senate tax writing committees have both said they want to move tax reform legislation in 2014 but the extent of any reform—and overall enthusiasm in Congress for reform—is unclear. Some lawmakers want a complete overhaul of the Tax Code (the last major tax reform was in 1986); others want to a more piece-meal approach. Lawmakers are also divided over whether reform should be revenue neutral or if reform should raise new revenues.

There had been some expectation that the budget agreement would include tax provisions, especially the so-called tax extenders. These are popular but temporary incentives, such as the higher education tuition deduction, state and local sales tax deduction, transit benefits parity, teacher’s classroom expense deduction, research tax credit, and more. The budget agreement negotiators decided not to include the extenders, which have now expired. Congress is likely to extend the incentives retroactive to January 1, 2014. If you have any questions about the status of an extender, please contact our office.

Looking ahead, President Obama is expected in his State of the Union Address in January and FY 2015 budget proposals to again call for a reduction in the corporate tax rate in exchange for eliminating some business tax incentives. The President made the same proposal last year but it failed to gain traction in Congress. The President is also likely to urge Congress to renew tax incentives that encourage employers to hire military veterans and individuals from economically-disadvantaged groups, consolidate some taxpayer penalties, extend enhanced small business expensing (and possibly bonus depreciation) and more. Our office will share details of the President’s proposals as they are released.

New IRS Commissioner

In May—after news broke of the IRS selecting applications from conservative groups for tax-exempt status for extra scrutiny—President Obama appointed Daniel Werfel to serve as Acting Commissioner. The President instructed Werfel to launch a top-down review of the agency. Since May, several senior IRS executives resigned or retired and Werfel appointed new top managers. Werfel also instituted cost-saving measures, such as eliminating employee conferences, curbing employee travel and not paying bonuses. Werfel, however, was never intended to serve permanently at the IRS and President Obama nominated John Koskinen to be Commissioner. The Senate approved Koskinen’s nomination in December.

Koskinen comes to the IRS after serving as the non-executive chair of Freddie Mac from 2008 to 2011. Previously, Koskinen was deputy mayor ofWashington,D.C.and also was a senior manager at the Office of Management and Budget (OMB). At his confirmation hearing, Senate Finance Committee (SFC) Chair Max Baucus, D-Montana, called Koskinen “the type of leader we need at the IRS.” SFC Ranking Member Orrin Hatch, R-Utah, reminded Koskinen that he has a “difficult job ahead” and “it is vital that the IRS maintain its credibility with taxpayers.” Koskinen told lawmakers that “trust is the most important asset the IRS has.”

Please contact our office if you have any questions about the filing season, tax legislation or IRS leadership changes.

Many higher-income taxpayers will be in for a big surprise when they finally tally up their 2013 tax bill before April 15th. The higher amount of taxes that may be owed will be the result of the combination of several factors, the cumulative effect of which will be significant for many. These factors include a higher income tax rate, a higher capital gains rate, a new net investment income tax, and a new Medicare surcharge on earned income, as well as a significantly reduced benefit from personal exemptions and itemized deductions for those in the higher income tax brackets.

Higher top income tax rate

The American Taxpayer Relief Act of 2012 made permanent for 2013 and beyond the lower Bush-era income tax rates for all, except for taxpayers with taxable income above $400,000 ($450,000 for married taxpayers filing jointly, $425,000 for heads of households). Income above these levels has now been taxed at a 39.6 percent rate rather than at the top 35 percent rate since January 1, 2013. Those amounts are adjusted for inflation after 2013 (for 2014, those threshold levels are $432,200, $457,600, and $406,750, respectively. Taxpayers with $150,000 of income above the threshold amounts, for example, must pay an additional $6,900 in tax in 2013 because of the additional tax rate of 4.6 percent).

Capital gains and dividends

The American Taxpayer Relief Act also raised the top rate for long-term capital gains and dividends to 20 percent, up from the Bush-era maximum 15 percent rate—again, applicable to all net long-term capital gains from transactions made on or after January 1, 2013. That top rate will apply to the extent that a taxpayer's income exceeds the thresholds set for the 39.6 percent rate ($400,000 for single filers; $450,000 for joint filers and $425,000 for heads of households). Especially applicable to those investors who have been riding the recent stock market rally, a jump in the rate from 15 percent to 20 percent represents a 33.33 percent tax increase.

Medicare Taxes

Set into motion on January 1, 2013 by the Affordable Care Act of 2010, higher-income taxpayers have been required to pay an additional 3.8 percent on net investment income as well as a 0.9 percent Additional Medicare Tax on earned income.

In both cases, the income threshold levels for being subject to these new taxes are considerably lower than the 39.6 percent bracket and 20 percent capital gain rates. The threshold amount is $200,000 in the case of a single individual, head of household (with qualifying person) and qualifying widow(er) with dependent child. The threshold amount is $250,000 in the case of a married couple filing jointly and $125,000 in the case of a married couple filing separately. For the 3.8 percent net investment income tax, the threshold is adjusted gross income (modified for certain foreign-based income). For the 0.9 percent  Additional Medicare Tax, the threshold is measured against compensation earned for the year (including self-employment income):

Net investment income tax. The 3.8 percent tax not only covers capital gains and dividends, but also passive-type income flowing from real estate, investments in businesses, and the like. The rules are complex, and many taxpayers will struggle with the extent to which income on their 2013 tax returns will be subject to the new net investment income tax. For income subject to this tax, the effective rate will increase to 23.8 percent on net capital gain and dividends and 43.4 percent on short-term capital gain and all other passive-type income.

Additional Medicare Tax. For tax years beginning after December 31, 2012, the 0.9 percent Additional Medicare Tax applies to employee compensation and self-employment income above the threshold amounts noted above. Covered wages for purposes of the Additional Medicare Tax include not only regular salary or payments for services rendered to someone self-employed, but also tips, commissions that are part of compensation, bonuses, reimbursements under nonaccountable plans, back pay awards, gifts by employers to employees and more.

An employer's withholding obligation for the Additional Medicare Tax applies only to the extent the employee's wages are in excess of $200,000 in a calendar year. For some dual-income couples with combined earned income above the $250,000 threshold but with no one earning more than $200,000, they may find themselves under withheld and subject to an estimated tax penalty as a result. Couples should remember that to prevent a reoccurrence in the future, an employee may request additional income tax withholding, which will be applied against all taxes shown on the individual's return, including any liability for the Additional Medical Tax.

Itemized Deductions Limitation

The American Taxpayer Relief Act officially the “Pease” limitation on itemized deductions. The new thresholds, first applied in 2013, are $300,000 for married couples and surviving spouses; $275,000 for heads of households; $250,000 for unmarried taxpayers; and $150,000 for married taxpayers filing separately.

The Pease limitation reduces the total amount of a higher-income taxpayer's otherwise allowable itemized deductions by three percent of the amount by which the taxpayer's adjusted gross income exceeds this applicable threshold. The amount of itemized deductions may be reduced up to 80 percent under this formula. Certain items, such as medical expenses, investment interest, and casualty, theft or wagering losses, are excluded.

Personal Exemption Phaseout

The American Taxpayer Relief Act also revived the personal exemption phaseout rules, at the same levels of adjusted gross income revived for the Pease limitation. Under the phaseout, the total amount of exemptions that may be claimed by a taxpayer is reduced by two percent for each $2,500, or portion thereof (two percent for each $1,250 for married couples filing separate returns) by which the taxpayer's adjusted gross income exceeds the applicable threshold level. At the full phase out level, therefore, a family with four personal exemptions in 2013 will lose $15,600 in exemptions, creating $6,178 in additional tax at the 39.6 percent bracket.

Federal Estate and Gift Taxes

One bright spot for higher-income taxpayers is the change that took place starting in 2013 directly applicable to estate planning strategies. The American Taxpayer Relief Act permanently provided for a maximum federal estate tax rate of 40 percent with an annual inflation-adjusted $5 million exclusion for estates of decedents dying after December 31, 2012. Couples can combine exclusions and effectively exempt $10 million from estate tax (for 2013, the inflation-adjusted level is $10.5 million, rising to $10.68 million in 2014).

If you would like a further assessment of how the new, “higher-income taxes” will impact what you owe for 2013 this coming April 15, or if you would like to start now to implement a plan to minimize these taxes in 2014, please do not hesitate to contact this office. 

Good recordkeeping is essential for individuals and businesses before, during, and after the upcoming tax filing season.

Good recordkeeping is essential for individuals and businesses before, during, and after the upcoming tax filing season.

First, the law actually requires taxpayers to retain certain records for a specified number of years, for example tax returns or employment tax records (for employers).

Second, good recordkeeping is essential for taxpayers while preparing their tax returns. The Tax Code frequently requires taxpayers to substantiate their income and claims for deductions and credits by providing records of various profits, expenses and transactions.

Third, if a taxpayer is ever audited by the IRS, good recordkeeping can facilitate what could be a long and invasive process, and it can often mean the difference between a no change and a hefty adjustment.

Finally, business taxpayers should maintain good records that will enable them to track the trajectory of their success over the years.

Here you will find a sample list of various types of records it would be wise to retain for tax and other purposes (not an exhaustive list; see this office for further customization to your particular situation):

Individuals

Filing status:

Marriage licenses or divorce decrees – Among other things, such records are important for determining filing status.

Determining/Substantiating income:

State and federal income tax returns – Tax records should be retained for at least three years, the length of the statute of limitations for audits and amending returns. However, in cases where the IRS determines a substantial understatement of tax or fraud, the statute of limitations is longer or can remain open indefinitely.

Paystubs, Forms W-2 and 1099, Pension Statements, Social Security Statements – These statements are essential for taxpayers determining their earned income on their tax returns. Taxpayers should also cross reference their wage and income reports with their final pay stubs to verify that their employer has reported the correct amount of income to the IRS.

Tip diary or other daily tip record – Taxpayers that receive some of their income from tips should keep a daily record of their tip income. Under the best circumstances, taxpayers would have already accurately reported their tip income to their employers, who would then report that amount to the IRS. However, mistakes can occur, and good recordkeeping can eliminate confusion when tax season arrives.

Military records – Some members of the military are exempt from state and/or federal tax; combat pay is exempt from taxation, as are veteran’s benefits. (In many cases, a record of military service is necessary to obtain veteran’s benefits in the first place.)

Copies of real estate purchase documents – Up to $500,000 of gain from the sale of a personal residence may be excludable from income (generally up to $250,000 if you are single). But if you own a home that sold for an amount that produces a greater amount of gain, or if you own real estate that is not used as your personal residence, you will need these records to prove your tax basis in your home; the greater your basis, the lower the amount of gain that must be recognized.

Individual Retirement Account (IRA) records – Funds contributed to Roth IRAs and traditional IRAs and the earnings thereon receive different tax treatments upon distribution, depending in part on when the distribution was made, what amount of the contributions were tax deferred when made, and other factors that make good recordkeeping desirable.

Investment purchase confirmation records – Long-term capital gains receive more favorable tax treatment than short-term capital gains. In addition, basis (generally the cost of certain investments when purchased) can be subtracted from gain from any sale. For these reasons, taxpayers should keep records of their investment purchase confirmations.

Substantiating deductions:

Acknowledgments of charitable donations – Cash contributions to charity cannot be deducted without a bank record, receipt, or other means. Charitable contributions of $250 or more must be substantiated by a contemporaneous written acknowledgment from the qualified organization that also meets the IRS requirements.

Cash payments of alimony – Payments of alimony may be deductible from the gross income of the paying spouse . . . if the spouse can substantiate the payments and certain other criteria are met.

Medical records – Disabled taxpayers under the age of 65 should keep a written statement from a qualified physician certifying they were totally disabled on the date of retirement.

Records of medical expenses – Certain unreimbursed medical expenses in excess of 10 percent of adjusted gross income may be deductible. Caution: a pending tax-reform proposal may change the deductibility of these expenses.

Mortgage statements and mortgage insurance – Mortgage interest and real estate taxes have generally deductible for taxpayers who itemize rather than claim the standard deduction. Caution: a pending tax-reform proposal may change the deductibility of these expenses.

Receipts for any improvements to real estate – Part or all of the expense of certain energy efficient real estate improvements can qualify taxpayers for one or more tax credits.

Keeping so many records can be tedious, but come tax-filing season it can result in large tax savings. And in the case of an audit, evidence of good recordkeeping can get you off to a good start with the IRS examiner handling the case, can save time, and can also save money. For more information on recordkeeping for individuals, please contact our offices.

Businesses

Taxpayers are required by law to keep permanent books of account or records that sufficiently substantiate the amount of gross income, deductions, credits and other amounts reported and claimed on any their tax returns and information returns.

Although, neither the Tax Code nor its regulations specify exactly what kinds of records satisfy the record-keeping requirements, here are a few suggestions:

State and federal income tax returns – These and any supporting documents should be kept for at least the period of limitations for each return. As with individual taxpayers, the limitations period for business tax returns may be extended in the event of a substantial understatement or fraud.

Employment taxes – The Tax Code requires employers to keep all records of employment taxes for at least four years after filing for the 4th quarter for the year. Generally these records would include wage payments and other payroll-related records, the amount of employment taxes withheld, reported tip income, identification information for employees and other payees; employees’ dates of employment; income tax withholding allowance certificates (Forms W-4, for example), fringe benefit payments, and more.

Business income – These would go toward substantiating income, and could include cash register tapes, bank deposit slips, a cash receipts journal, annual financial statements, Forms 1099, and more.

Inventory costs – Businesses should keep records of inventory purchases. For example, if an electronics company purchases a certain number of widgets for resale or a manufacturer purchases a certain number of ball bearings for use in the production of industrial equipment that it manufactures and sells. The costs of these goods, parts, or other materials can be deducted from sales income to significantly reduce tax liability.

Business expenses – Ordinary and necessary expenses for carrying on business, such as the cost of rental office space, are also generally deductible from business income. Such expenses can be substantiated through bank statements, canceled checks, credit card receipts or other such records. The cost of making certain improvements to a business, such as through buying equipment or renovating property, can also be deductible.

Electronic back-up

Paper records can take up a great deal of storage space, and they are also vulnerable to destruction in fires, floods, earthquakes, or other natural phenomena. Because records are required to substantiate most income, deductions, property values and more—even when they no longer exist—taxpayers (and especially business taxpayers) should digitize their records on an electronic storage system and keep a back-up copy in a secure location.

Business taxation can be extremely complicated, and the requirements for recordkeeping vary greatly depending on the size of the business, the form of organization chosen, and the type of industry in which the business operates. For more details on your specific situation, please call our offices.

Taxpayers who use their automobiles for business or the production of income can deduct their actual expenses for use of an automobile (including the use of vans, pickups, and panel trucks) that the taxpayer owns or leases. Deductible expenses include parking fees, tolls, taxes, depreciation, repairs and maintenance, tires, gas, oil, insurance and registration.

Standard rate for business

Employees and self-employed individuals can use the optional business standard mileage rate, instead of tracking actual costs for depreciation, repairs and maintenance, tires, gas, insurance, oil and registration. Vehicle costs based on the standard rate are determined by multiplying the number of business miles traveled during the year by the rate. In addition to taking the standard rate, a taxpayer can deduct certain other costs as separate items, including as parking, tolls, interest on the purchase of the automobile, and state and local personal property taxes.

For 2014, the standard mileage rate for business travel is 56 cents per mile, a slight drop from the 2013 rate of 56.5 cents per mile. This allowance includes depreciation of 22 cents per mile for 2014. A taxpayer using the standard mileage rate must reduce the basis of the vehicle by the depreciation expenses included in the mileage rate.

(While the use of actual expenses may result in a greater deduction than using the standard rate, this must be balanced against the added recordkeeping and substantiation burdens.)

Substantiation and limitations

A taxpayer using the standard mileage rate does not have to substantiate the expense amounts covered by the rate. However, the taxpayer must properly substantiate other travel elements, such as time, place and purpose of the trip. Travel expenses must be substantiated either by adequate records or by sufficient evidence corroborating the taxpayer's own statement. To meet the adequate records requirement, a taxpayer should maintain an account book, diary or similar statement and documentary evidence to establish each element of the expense.

A taxpayer cannot use the standard mileage rate if it operates five or more vehicles at the same time, if it claimed a Code Sec. 179 expensing deduction for the vehicle, or if it claimed depreciation other than straight-line depreciation.

Other standard mileage rates

The IRS also provides standard mileage rates for medical and moving expenses. For 2014, the rate is 23.5 cents per mile (down from 24 cents for 2013). The standard rate for charitable expenses is set by statute and remains at 14 cents per mile. The various standard mileage rates for 2014 apply to miles driven on or after January 1, 2014.

The definitive arrival of the New Year does not spell doom for all tax savings opportunities for 2013. A few options remain to taxpayers:

IRAs

Taxpayers have until April 15, 2014, to make tax-deferred contributions to a traditional individual retirement account (IRA). The amount any one taxpayer may contribute to an IRA is limited to $5,500 per taxpayer ($6,500 for taxpayers age 50 or older).

This amount begins to phase out after the taxpayer has adjusted gross income (AGI) over a certain amount ($59,000 for single and head of household filers; $95,000 for married filers). The phase out is complete once the taxpayer’s AGI exceeds $69,000 (single and head of household filers) or $115,000 (married filers).

If the taxpayer has already contributed to an IRA for 2013 (including a Roth IRA), the allowed $5,500 contribution is reduced by the amount of those previous contributions.

HSAs

Taxpayers covered under a high-deductible health plan (HDHP) also have until April 15, 2014, to make tax-deferred contributions to a health savings account (HSA). An HSA is a tax-exempt trust or custodial account established for the purpose of paying the beneficiary’s qualified medical expenses.

Estimated tax

Taxpayers who realize they should have been making estimated payments of tax throughout the year can avoid penalties for the fourth quarter of 2013 by making an estimated tax payment on or before January 15, 2014.

Other notable tax deadlines, other than the looming April 15, 2014 deadline for individual returns, include:

March 15: Taxpayers who contributed funds during 2013 to an employer-sponsored cafeteria plan through a flexible spending arrangement (FSA) have until March 15, 2014 to use them on any qualified medical expenses. Generally taxpayers must use all funds contributed to an FSA before the end of the year, unless their employer has amended the cafeteria plan to allow a grace period up until March 15. Taxpayers who are unsure of whether or not their flexible spending arrangement provides this grace period should contact their employer.

April 1: Taxpayers that have traditional IRAs are required to start taking minimum distributions from their IRAs in the year in which they turn age 70½. These are called required minimum distributions (RMDs), and they are calculated based on the account holder’s life expectancy. RMDs are required for traditional IRAs, but not Roth IRAs.

Taxpayers who just turned 70½ during 2013 may delay the first payment until April 1, 2014. However, for all years thereafter, the taxpayer must take the RMD by December 31 of the tax year. This means that a taxpayer who delays his or her first RMD payment until April 1, 2014, will be required to report two RMDs in his or her 2014 income.

Account owners who do no withdraw the full RMD amount by the deadline will be liable for tax at the rate of 50 percent on the amount not withdrawn

For more information on the upcoming tax return filing season, please contact our offices. 

Tax season is scheduled to begin shortly and, as in past years, there are some possible glitches to be mindful of. Already, the IRS has alerted taxpayers that the start of filing season will be delayed. Late tax legislation, although unlikely, could result in a further delay. Some new requirements under the Patient Protection and Affordable Care Act have been waived for 2014, but others have not. The IRS also is facing the prospect of another government shutdown in January.

Tax season is scheduled to begin shortly and, as in past years, there are some possible glitches to be mindful of. Already, the IRS has alerted taxpayers that the start of filing season will be delayed. Late tax legislation, although unlikely, could result in a further delay. Some new requirements under the Patient Protection and Affordable Care Act have been waived for 2014, but others have not. The IRS also is facing the prospect of another government shutdown in January.

Filing season

In recent years, the IRS has had to delay the start of the filing season to reprogram its return processing systems for changes in the tax laws. The 2014 filing season will also be delayed but not, as of today, because of new tax laws. The IRS operated with minimal staffing during the 16-day government shutdown in October and fell behind in its scheduled maintenance and programming of its return processing systems because employees were furloughed. At this time, the IRS expects the 2014 filing season to be delayed for possibly two weeks.

Before the shutdown, the IRS had anticipated opening the 2014 filing season on January 21, 2014. With a one- to two-week delay, the IRS would start accepting and processing returns no earlier than January 28, 2014 and no later than February 4, 2014. Individuals who file early in anticipation of receiving a refund will likely see their refunds delayed. The IRS is expected to make a final determination on the start date of the 2014 filing season in mid-December. Our office will keep you posted of developments.

Taxpayers are also waiting on some important final forms for the 2014 filing season, including Form 8960, Net Investment Income Tax. The Affordable Care Act created the new 3.8 tax on qualified net investment income, effective January 1, 2013. Additionally, the IRS has indicated that more guidance will be available for married same-sex couples. Since publication of the IRS's initial guidance, questions have surfaced concerning employee benefits, return filing and other issues affecting married same-sex couples and domestic partners (whom the IRS does not treat as married). Late-year guidance on either the 3.8 percent net investment income tax or same-sex tax issues may require last-minute changes in year-end tax strategies.

Another shutdown possible

The IRS is currently operating under a stop-gap funding measure, which ended the government shutdown in October. Funding under the stop-gap measure is scheduled to lapse after January 15, 2014. A House-Senate budget conference committee is attempting to reconcile competing fiscal year (FY) 2014 budget bills. So far, lawmakers appear to have made little progress.

A mid-January shutdown could further delay the start of the filing season. In a November 18 letter to IRS Acting Commissioner Daniel Werfel, the American Institute of Certified Public Accountants (AICPA) expressed concern that another government shutdown would result in a huge strain on taxpayers and tax professionals trying to timely file and report their income taxes by April 15. "The IRS keeping more essential positions working during January would help make the already delayed filing season operate as smoothly as possible," the AICPA told Werfel. The AICPA also recommended that the Taxpayer Advocate Service, which closed during the October shutdown, remain open in the event of another lapse in appropriations.

Tax legislation

Although many tax bills have been introduced in Congress, 2013 is likely to end without lawmakers tackling comprehensive tax reform. The House Ways and Means Committee and the Senate Finance Committee have both prepared discussion drafts on tax reform, covering a host of tax issues. One possible reason for the lack of movement of tax reform appears to be lukewarm interest, at best, from the House and Senate leaders. This could change in 2014 but it is too early to make any predictions.

One path for tax reform could be the House-Senate budget conference committee. However, as mentioned, the committee has not yet produced any concrete proposals. Several lawmakers have recommended that the committee strike a deal to lower corporate tax rates in exchange for businesses giving up unspecified tax breaks. Many Republicans want to keep scheduled across-the-board spending cuts in place for 2014 and beyond; many Democrats want to replace the spending cuts with new revenue raisers. The conference committee has a mid-December deadline to reach an agreement.

A package of so-called tax extenders-popular but temporary tax incentives-could move before year-end but more likely will be taken up by Congress early next year. Unlike last year, the expiring incentives do not affect 2013 returns filed in 2014. Eligible taxpayers will be able to claim the state and local sales tax deduction, the higher education tuition deduction, the teachers' classroom expense deduction, home energy tax breaks, and many others on their 2013 returns. If you have any questions about the expiring incentives, please contact our office.

Affordable Care Act

Starting January 1, 2014, the Affordable Care Act requires individuals to carry minimum essential health insurance (unless they are exempt) or make a shared responsibility payment. Tax credits and cost-sharing also kick-in next year. At this time, it appears unlikely that the Obama administration will delay the individual mandate. The employer mandate, however, is delayed. Employer reporting (and reporting by some insurers) will not apply until 2015, but is optional for 2014. Generally, employer reporting applies to employers with at least 50 full-time employees on business days during the preceding calendar year.

November was dominated by news of technical troubles for the online Affordable Care Act Marketplaces and the cancellation of some individual insurance policies that did not meet new standards. The White House has made getting the online Marketplaces running at 100 percent a priority and also gave states the option of allowing individuals to re-enroll in coverage that would otherwise be terminated. The fix is temporary and individuals will need to find alternative coverage for 2015 and beyond. Small businesses also may have received cancellation notices and should be exploring alternative coverage.

If you have any questions about year-end tax developments, please contact our office.

Health flexible spending arrangements (health FSAs) are popular savings vehicles for medical expenses, but their use has been held back by a strict use-or-lose rule. The IRS recently announced a significant change to encourage more employers to offer health FSAs and boost enrollment. At the plan sponsor's option, employees participating in health FSAs will be able to carry over, instead of forfeiting, up to $500 of unused funds remaining at year-end.

Health flexible spending arrangements (health FSAs) are popular savings vehicles for medical expenses, but their use has been held back by a strict use-or-lose rule. The IRS recently announced a significant change to encourage more employers to offer health FSAs and boost enrollment. At the plan sponsor's option, employees participating in health FSAs will be able to carry over, instead of forfeiting, up to $500 of unused funds remaining at year-end.

Health expenses

Health FSAs are designed to reimburse participants for certain health care expenditures, typically expenses that qualify for the medical and dental expense deduction. Medical supplies, such as eye glasses and bandages, are usually treated as qualified expenses. However, nonprescription medicines (other than insulin) are not considered qualified medical expenses.

Health FSAs are often funded through voluntary salary reduction agreements with the participant's employer under a cafeteria plan. In that case, they are very taxpayer-friendly because no federal employment or federal income taxes are deducted from the employee's contribution. The employer may also contribute to a health FSA. However, there are special rules which govern employer contributions.

Typically, participants designate at the beginning of the year the amount they want to contribute to their health FSA and these amounts are deducted from their pay. For 2014, an employee's salary reduction contributions cannot exceed $2,500. The $2,500 cap is very important because cafeteria plans that do not limit health FSA contributions to $2,500 are not treated as cafeteria plans, and all benefits offered under the plan are included in the participants' gross income.

Use-or-lose rule

As mentioned, the use-or-lose rule is a drawback to health FSAs. Unused amounts remaining in the health FSA at year-end are forfeited. Employers are not allowed to refund any unused funds in a health FSA. Critics of the use-or-lose rule argue that it has discouraged participation in health FSAs because many employees do not want to risk forfeiting unused funds. Often, participants have to scramble at year-end to use their health FSA dollars

Grace period option

A few years ago, the IRS modified the use-or-lose rule. The IRS allowed cafeteria plans to adopt a grace period. Participants can use amounts remaining in a health FSA at year-end for up to an additional two months and 15 days. This grace period is optional. Employers are not required to offer the grace period, although many do.

Carryover option

At its option, an employer may now amend its cafeteria plan to provide for the carryover to the immediately following year of up to $500 of any amount remaining unused as of the end of the year in a health FSA. The carryover of up to $500 may be used to pay or reimburse qualified expenses under the health FSA incurred during the entire plan year to which it is carried over. Additionally, the carryover does not count against or otherwise affect the salary reduction limit ($2,500 for 2014) for health FSAs. However, the new rules do not allow participants to cash out unused health FSA amounts or convert them to other types of benefits.

The maximum carryover amount is $500. An employer can choose to offer a $0 carryover, a $500 carryover or any amount in between. As we discussed, the carryover is optional. Employers can choose not to offer any carryover.

Employers cannot offer both the grace period and the carryover. It is a choice of either the grace period or the carryover....or neither. The employer and not the participant decides. In regulations, the IRS described how employers can amend their cafeteria plans to provide for the carryover and how they can, if they choose, replace the grace period with the carryover.

Let's take a look at an example: Jacob participates in a health FSA under his employer's cafeteria plan. At year-end, Jacob has $255 remaining in his health FSA. Jacob's employer never offered a grace period but opted to allow participants to carry over up to $300 of unused health FSA dollars. Jacob can carry over all of his $255 in unused health FSA dollars.

If you have any questions about the new carryover option or health FSAs, please contact our office.

Notice 2013-71

Taxpayers generally prefer to accelerate deductions to reduce their current year income and taxes. In some situations, the tax code's accounting rules allow an accrual-basis employer to deduct a year-end employee bonus in the current year, even though the bonus will not be paid until the following year. A recent IRS Chief Counsel memorandum (FAA 20134301F) highlights some of the pitfalls that can affect when bonus compensation is deductible.

Taxpayers generally prefer to accelerate deductions to reduce their current year income and taxes. In some situations, the tax code's accounting rules allow an accrual-basis employer to deduct a year-end employee bonus in the current year, even though the bonus will not be paid until the following year. A recent IRS Chief Counsel memorandum (FAA 20134301F) highlights some of the pitfalls that can affect when bonus compensation is deductible.

Accrual Method

Under the accrual-method of accounting (in contrast to the cash-method of accounting), a liability is incurred, and can be deducted, in the year in which:

1. All the events have occurred that establish the fact of the liability;
2. The amount of the liability can be determined with reasonable accuracy; and
3. Economic performance has occurred.

The first factor, the all-events test, is met when the event fixing the liability occurs and payment is unconditionally due. Although an expense may be deductible before it is payable, liability must be firmly established. The "fact of liability" depends on whether legal rights or obligations exist as of the close of the year, not the probability that the rights will arise in the future.

Bonus Plans

An employer may establish an arrangement or plan that will pay a bonus to its employees in the succeeding year, based on an evaluation of current year performance. Performance could be determined by objective factors, such as numerical goals set for the company or the employee. These bonuses may be deductible in the earlier year even though the employee, who must figure taxes on the cash method, won't need to recognize the income until it is paid. Or performance may be based on more subjective factors, such as an individual performance appraisal or the employer's discretion. These bonuses may be deductible in the later year. The requirements for awarding the bonus must be scrutinized, to determine when the liability becomes certain.

Is the liability deductible?

The IRS has stated that a bonus can be deducted in the current year if, under a bonus plan, the employee is notified in the current year the employee will receive a bonus, even though the bonus is not calculated or paid until the following year. An employer's bonus liability that is ascertainable by a fixed standard, such as a percentage of profits at the close of the year, accrues and is deductible in the current year even though the computations are not made until the following year.

A bonus is not deductible prior to payment if an employee must remain employed until the time of payment, and if a forfeited bonus reverts to the employer. However, even if an employee must be employed until paid, the IRS has ruled that a bonus is deductible under a pooled arrangement providing that any forfeited bonuses are reallocated to the employees as a group, where the minimum amount payable to the group is determinable through a fixed formula at the end of the year or by board action before the end of the year.

Employers may be denied a deduction in the current year if there are uncertainties or conditions on payment. As stated above, a condition that the employee must remain with the company until payment prevents accrual before the payment. A deduction is not available if the payment is subject to significant contingencies involving corporate affairs, such as approval by the board, or a requirement that the company attain a particular cash position. If there is no set formula, and bonuses will not be determined until after the close of the year, the bonuses do not accrue until the later year.

In the IRS memorandum, Chief Counsel determined that a bonus could not be accrued in the earlier year in the following situations:

1. The employer retained the right to unilaterally modify or eliminate the bonus plan or the bonuses themselves at any time, in its discretion. The employer had no legal obligation to pay the bonus until it was actually paid.
2. The plan requires a committee of the board of directors to act in the following year to approve the bonus computation and the payment of bonuses. There is no legal obligation because the committee must approve the bonuses, and that approval is not automatic.
3. The bonus depends not only on objective formulas but also on the employee's individual performance score, based on appraisals that are not performed until after the end of the year.

There is a tension between the employer's desire to accelerate the deduction and its desire to retain maximum control over the payment of bonuses. An employer that wants to deduct the bonuses in an earlier year must be willing to relinquish some of its discretion to determine the bonus.

Whether for a day, a week or longer, many of the costs associated with business trips may be tax-deductible. The tax code includes a myriad of rules designed to prevent abuses of tax-deductible business travel. One concern is that taxpayers will disguise personal trips as business trips. However, there are times when taxpayers can include some personal activities along with business travel and not run afoul of the IRS.

Business travel

You are considered “traveling away from home” for tax purposes if your duties require you to be away from the general area of your home for a period substantially longer than an ordinary day's work, and you need sleep or rest to meet the demands of work while away. Taxpayers who travel on business may deduct travel expenses if they are not otherwise lavish or extravagant. Business travel expenses include the costs of getting to and from the business destination and any business-related expenses at that destination.

Deductible travel expenses while away from home include, but are not limited to, the costs of:

• Travel by airplane, train, bus, or car to/from the business destination.
• Fares for taxis or other types of transportation between the airport or train station and lodging, the lodging location and the work location, and from one customer to another, or from one place of business to another.
• Meals and lodging.
• Tips for services related to any of these expenses.
• Dry cleaning and laundry.
• Business calls while on the business trip.
• Other similar ordinary and necessary expenses related to business travel.

Business mixed with personal travel

Travel that is primarily for personal reasons, such as a vacation, is a nondeductible personal expense. However, taxpayers often mix personal travel with business travel. In many cases, business travelers may able to engage in some non-business activities and not lose all of the tax benefits associated with business travel.

The primary purpose of a trip is determined by looking at the facts and circumstances of each case. An important factor is the amount of time you spent on personal activities during the trip as compared to the amount of time spent on activities directly relating to business.

Let’s look at an example. Amanda, a self-employed architect, resides in Seattle. Amanda travels on business to Denver. Her business trip lasts six days. Before departing for home, Amanda travels to Colorado Springs to visit her son, Jeffrey. Amanda’s total expenses are $1,800 for the nine days that she was away from home. If Amanda had not stopped in Colorado Springs, her trip would have been gone only six days and the total cost would have been $1,200. According to past IRS precedent, Amanda can deduct $1,200 for the trip, including the cost of round-trip transportation to and from Denver.

Weekend stayovers

Business travel often concludes on a Friday but it may be more economical to stay over Saturday night and take advantage of a lower travel fare. Generally, the costs of the weekend stayover are deductible as long as they are reasonable. Staying over a Saturday night is one way to add some personal time to a business trip.

Foreign travel

The rules for foreign travel are particularly complex.  The amount of deductible travel expenses for foreign travel is linked to how much of the trip was business related.  Generally, an individual can deduct all of his or her travel expenses of getting to and from the business destination if the trip is entirely for business.

In certain cases, foreign travel is considered entirely for business even if the taxpayer did not spend his or her entire time on business activities. For example, a foreign business trip is considered entirely for business if the taxpayer was outside the U.S. for more than one week and he or she spent less than 25 percent of the total time outside the U.S. on non-business activities. Other exceptions exist for business travel outside the U.S. for less than one week and in cases where the employee did not have substantial control in planning the trip.

Foreign conventions are especially difficult, but no impossible, to write off depending upon the circumstances. The taxpayer may deduct expenses incurred in attending foreign convention seminar or similar meeting only if it is directly related to active conduct of trade or business and if it is as reasonable to be held outside North American area as within North American area.

Tax home

To determine if an individual is traveling away from home on business, the first step is to determine the location of the taxpayer’s tax home. A taxpayer’s tax home is generally his or her regular place of business, regardless of where he or she maintains his or her family home. An individual may not have a regular or main place of business. In these cases, the individual’s tax home would generally be the place where he or she regularly lives.  The duration of an assignment is also a factor. If an assignment or job away from the individual’s main place of work is temporary, his or her tax home does not change. Generally, a temporary assignment is one that lasts less than one year.

The distinction between tax home and family home is important, among other reasons, to determine if certain deductions are allowed. Here’s an example.

Alec’s family home is in Tucson, where he works for ABC Co. 14 weeks a year.  Alec spends the remaining 38 weeks of the year working for ABC Co. in San Diego. Alec has maintained this work schedule for the past three years. While in San Diego, Alec resides in a hotel and takes most of his meals at restaurants.  San Diego would be treated as Alec’s tax home because he spends most of his time there. Consequently, Alec would not be able to deduct the costs of lodging and meals in San Diego.

Accountable and nonaccountable plans

Many employees are reimbursed by their employer for business travel expenses. Depending on the type of plan the employer has, the reimbursement for business travel may or may not be taxable. There are two types of plans: accountable plans and nonaccountable plans.

An accountable plan is not taxable to the employee. Amounts paid under an accountable plan are not wages and are not subject to income tax withholding and federal employment taxes. Accountable plans have a number of requirements:

• There must be a business connection to the expenditure. The expense must be a deductible business expense incurred in connection with services performed as an employee. If not reimbursed by the employer, the expense would be deductible by the employee on his or her individual income tax return.

• There must be adequate accounting by the recipient within a reasonable period of time. Employees must verify the date, time, place, amount and the business purpose of the expenses.

• Excess reimbursements or advances must be returned within a reasonable period of time.

Amounts paid under a nonaccountable plan are taxable to employees and are subject to all employment taxes and withholding.  A plan may be labeled an accountable plan but if it fails to qualify, the IRS treats it as a nonaccountable plan. If you have any questions about accountable plans, please contact our office.

As mentioned, the tax rules for business travel are complex. Please contact our office if you have any questions.

Exempt organizations

Charitable organizations often are organized as tax-exempt entities. To be tax-exempt under Code Sec. 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes in Code Sec. 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization; that is, it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates. Churches that meet the requirements of Code Sec. 501(c)(3) are automatically considered tax exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS.

Tax-exempt organizations must file annual reports with the IRS. If an organization fails to file the required reports for three consecutive years, its tax-exempt status is automatically revoked. Recently, the tax-exempt status of more than 200,000 organizations was automatically revoked. Most of these organizations are very small ones and the IRS believes that they likely did not know about the requirement to file or risk loss of tax-exempt status.  The IRS has put special procedures in place to help these small organizations regain their tax-exempt status.

Contributions

Contributions to qualified charities are tax-deductible. They key word here is qualified. The organization must be recognized by the IRS as a legitimate charity.

The IRS maintains a list of organizations eligible to receive tax-deductible charitable contributions. The list is known as Publication 78, Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986.  Similar information is available on an IRS Business Master File (BMF) extract.

In certain cases, the IRS will allow deductions for contributions to organizations that have lost their exempt status but are listed in or covered by Publication 78 or the BMF extract.  Additionally, private foundations and sponsoring organizations of donor-advised funds generally may rely on an organization's foundation status (or supporting organization type) set forth in Publication 78 or the BMF extract for grant-making purposes.

Generally, the donor must be unaware of the change in status of the organization. If the donor had knowledge of the organization’s revocation of exempt status, knew that revocation was imminent or was responsible for the loss of status, the IRS will disallow any purported deduction.

Churches

As mentioned earlier, churches are not required to apply for tax-exempt status. This means that taxpayers may claim a charitable deduction for donations to a church that meets the Code Sec. 501(c)(3) requirements even though the church has neither sought nor received IRS recognition that it is tax-exempt.

Foreign charities

Contributions to foreign charities may be deductible under an income tax treaty. For example, taxpayers may be able to deduct contributions to certain Canadian charitable organizations covered under an income tax treaty with Canada.  Before donating to a foreign charity, please contact our office and we can determine if the contribution meets the IRS requirements for deductibility.

The rules governing charities, tax-exempt organizations and contributions are complex. Please contact our office if you have any questions.

The IRS's streamlined offer-in-compromise (OIC) program is intended to speed up the processing of OICs for qualified taxpayers. Having started in 2010, the streamlined OIC program is relatively new. The IRS recently issued instructions to its examiners, urging them to process streamlined OICs as expeditiously as possible. One recent survey estimates that one in 15 taxpayers is now in arrears on tax payments to the IRS to at least some degree.  Because of continuing fallout from the economic downturn, however, the IRS has tried to speed up its compromise process to the advantage of both hard-pressed taxpayers and its collection numbers.

OIC program

The IRS OIC program on its face can appear very attractive to taxpayers with unpaid liabilities. An OIC is an agreement between a taxpayer and the IRS that settles the taxpayer's tax liabilities for less than the full amount owed. Keep in mind that taxpayers do not automatically qualify for an OIC. The IRS has cautioned that, absent special circumstances, if you have the ability to fully pay your tax liability in a lump sum or via an installment agreement, an OIC will not be accepted.

The IRS may accept an offer in compromise based on three grounds:

• Doubt as to collectibility
• Doubt as to liability
• Effective tax administration

The decision whether to accept or reject an OIC is entirely within the discretion of the IRS. Sometimes, but very rarely, an OIC will be deemed accepted because the IRS failed to reject it within 24 months of receiving the offer.

Streamlined OICs

The low acceptance rate of OICs has some lawmakers in Congress and taxpayer groups upset. One of the most vocal critics has been National Taxpayer Advocate Nina Olson who has urged the IRS to bring more taxpayers into the OIC program. Partly in response to this criticism, the IRS launched the streamlined OIC in 2010. The streamlined OIC program is intended to cut through much of the red tape that surrounds OICs. The IRS promised, among other things, to process streamlined OICs more quickly.

In February 2011, the IRS announced some changes to streamlined OICs. Streamlined OICs may be offered to taxpayers with total household incomes of $100,000 or less and who have a total tax liability of less than $50,000. Taxpayers who do not meet these requirements may apply for a traditional OIC.

Procedures

The streamlined procedures do not necessarily mean that the IRS will accept more OICs; merely that it will process the offers it receives more quickly. Since the streamlined OIC program is relatively new, the IRS has not yet reported how many streamlined offers it has accepted.

Before accepting or rejecting a streamlined OIC, IRS examiners must verify that the information provided by the taxpayer is correct. The IRS instructed examiners reviewing streamlined OICs to verify taxpayer information through internal research. Examiners will verify ownership of items such as real estate, motor vehicles and other property.

Examiners also will be able to communicate directly with taxpayers or their representatives. The IRS instructed examiners to contact taxpayers or their representatives by telephone whenever possible; rather than sending written notices. Three phone attempts should be made over two business days to contact the taxpayer or his/her representative. If the examiner reaches the taxpayer's voicemail, the examiners should request a call-back within two business days.

The streamlined OIC program is not for everyone. Indeed, the acceptance rate for all OICs (just about 13,000 in fiscal year (FY) 2010) means that relatively few taxpayers will make an offer that the IRS will accept. Nonetheless, the OIC program is one tool that may be used by taxpayers with unpaid liabilities. If you have any questions about the IRS's streamlined OIC or traditional OIC, please contact our office.

A limited liability company (LLC) is a business entity created under state law. Every state and the District of Columbia have LLC statutes that govern the formation and operation of LLCs.

The main advantage of an LLC is that in general its members are not personally liable for the debts of the business. Members of LLCs enjoy similar protections from personal liability for business obligations as shareholders in a corporation or limited partners in a limited partnership. Unlike the limited partnership form, which requires that there must be at least one general partner who is personally liable for all the debts of the business, no such requirement exists in an LLC.

A second significant advantage is the flexibility of an LLC to choose its federal tax treatment. Under IRS's "check-the-box rules, an LLC can be taxed as a partnership, C corporation or S corporation for federal income tax purposes. A single-member LLC may elect to be disregarded for federal income tax purposes or taxed as an association (corporation).

LLCs are typically used for entrepreneurial enterprises with small numbers of active participants, family and other closely held businesses, real estate investments, joint ventures, and investment partnerships. However, almost any business that is not contemplating an initial public offering (IPO) in the near future might consider using an LLC as its entity of choice.

Deciding to convert an LLC to a corporation later generally has no federal tax consequences. This is rarely the case when converting a corporation to an LLC. Therefore, when in doubt between forming an LLC or a corporation at the time a business in starting up, it is often wise to opt to form an LLC. As always, exceptions apply. Another alternative from the tax side of planning is electing "S Corporation" tax status under the Internal Revenue Code.

Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.

Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.

The IRS requires that business owners keep adequate books and records and that they be available when needed for the administration of any provision of the Internal Revenue Code (i.e., an audit). Here are some basic guidelines:

Copies of tax returns. You must keep records that support each item of income or deduction on a business return until the statute of limitations for that return expires. In general, the statute of limitations is three years after the date on which the return was filed. Because the IRS may go back as far as six years to audit a tax return when a substantial understatement of income is suspected, it may be prudent to keep records for at least six years. In cases of suspected tax fraud or if a return is never filed, the statute of limitations never expires.

Employment taxes. Chances are that if you have employees, you've accumulated a great deal of paperwork over the years. The IRS isn't looking to give you a break either: you are required to keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later. These records include payroll tax returns and employee time documentation.

Business assets. Records relating to business assets should be kept until the statute of limitations expires for the year in which you dispose of the asset in a taxable disposition. Original acquisition documentation, (e.g. receipts, escrow statements) should be kept to compute any depreciation, amortization, or depletion deduction, and to later determine your cost basis for computing gain or loss when you sell or otherwise dispose of the asset. If your business has leased property that qualifies as a capital lease, you should retain the underlying lease agreement in case the IRS ever questions the nature of the lease.

For property received in a nontaxable exchange, additional documentation must be kept. With this type of transaction, your cost basis in the new property is the same as the cost basis of the property you disposed of, increased by the money you paid. You must keep the records on the old property, as well as on the new property, until the statute of limitations expires for the year in which you dispose of the new property in a taxable disposition.

Inventories. If your business maintains inventory, your recordkeeping requirements are even more arduous. The use of special inventory valuation methods (e.g. LIFO and UNICAP) may prolong the record retention period. For example, if you use the last-in, first-out (LIFO) method of accounting for inventory, you will need to maintain the records necessary to substantiate all costs since the first year you used LIFO.

Specific Computerized Systems Requirements

If your company has modified, or is considering modifying its computer, recordkeeping and/or imaging systems, it is essential that you take the IRS's recently updated recordkeeping requirements into consideration.

If you use a computerized system, you must be able to produce sufficient legible records to support and verify amounts shown on your business tax return and determine your correct tax liability. To meet this qualification, the machine-sensible records must reconcile with your books and business tax return. These records must provide enough detail to identify the underlying source documents. You must also keep all machine-sensible records and a complete description of the computerized portion of your recordkeeping system.

Some additional advice: when your records are no longer needed for tax purposes, think twice before discarding them; they may still be needed for other nontax purposes. Besides the wealth of information good records provide for business planning purposes, insurance companies and/or creditors may have different record retention requirements than the IRS.

After your tax returns have been filed, several questions arise: What do you do with the stack of paperwork? What should you keep? What should you throw away? Will you ever need any of these documents again? Fortunately, recent tax provisions have made it easier for you to part with some of your tax-related clutter.

After your tax returns have been filed, several questions arise: What do you do with the stack of paperwork? What should you keep? What should you throw away? Will you ever need any of these documents again? Fortunately, recent tax provisions have made it easier for you to part with some of your tax-related clutter.

The IRS Restructuring and Reform Act of 1998 created quite a stir when it shifted the "burden of proof" from the taxpayer to the IRS. Although it would appear that this would translate into less of a headache for taxpayers (from a recordkeeping standpoint at least), it doesn't let us off of the hook entirely. Keeping good records is still the best defense against any future questions that the IRS may bring up. Here are some basic guidelines for you to follow as you sift through your tax and financial records:

Copies of returns. Your returns (and all supporting documentation) should be kept until the expiration of the statute of limitations for that tax year, which in most cases is three years after the date on which the return was filed. It's recommended that you keep your tax records for six years, since in some cases where a substantial understatement of income exists, the IRS may go back as far as six years to audit a tax return. In cases of suspected tax fraud or if you never file a return at all, the statute of limitations never expires.

Personal residence. With tax provisions allowing couples to generally take the first $500,000 of profits from the sale of their home tax-free, some people may think this is a good time to purge all of those escrow documents and improvement records. And for most people it is true that you only need to keep papers that document how much you paid for the house, the cost of any major improvements, and any depreciation taken over the years. But before you light a match to the rest of the heap, you need to consider the possibility of the following scenarios:

• • Your gain is more than $500,000 when you eventually sell your house. It could happen. If you couple past deferred gains from prior home sales with future appreciation and inflation, you could be looking at a substantial gain when you sell your house 15+ years from now. It's also possible that tax laws will change in that time, meaning you'll want every scrap of documentation that will support a larger cost basis in the home sold.
  • You did not use the home as a principal residence for a period. A relatively new income inclusion rule applies to home sales after December 31, 2008. Under the Housing and Economic Recovery Act of 2008, gain from the sale of a principal residence will no longer be excluded from gross income for periods that the home was not used as the principal residence. These periods of time are referred to as "non-qualifying use." The rule applies to sales occurring after December 31, 2008, but is based only on non-qualified use periods beginning on or after January 1, 2009. The amount of gain attributed to periods of non-qualified use is the amount of gain multiplied by a fraction, the numerator of which is the aggregate period of non-qualified use during which the property was owned by the taxpayer and the denominator of which is the period the taxpayer owned the property. Remember, however, that "non-qualified" use does not include any use prior to 2009.

• • You may divorce or become widowed. While realizing more than a $500,000 gain on the sale of a home seems unattainable for most people, the gain exclusion for single people is only $250,000, definitely a more realistic number. While a widow(er) will most likely get some relief due to a step-up in basis upon the death of a spouse, an individual may find themselves with a taxable gain if they receive the house in a property settlement pursuant to a divorce. Here again, sufficient documentation to prove a larger cost basis is desirable.

Individual Retirement Accounts. Roth IRA and education IRAs require varying degrees of recordkeeping:

• • Traditional IRAs. Distributions from traditional IRAs are taxable to the extent that the distributions exceed the holder's cost basis in the IRA. If you have made any nondeductible IRA contributions, then you may have basis in your IRAs. Records of IRA contributions and distributions must be kept until all funds have been withdrawn. Form 8606, Nondeductible IRAs, is used to keep track of the cost basis of your IRAs on an ongoing basis.

• • Roth IRAs. Earnings from Roth IRAs are not taxable except in certain cases where there is a premature distribution prior to reaching age 59 1/2. Therefore, recordkeeping for this type of IRA is the fairly simple. Statements from your IRA trustee may be worth keeping in order to document contributions that were made should you ever need to take a withdrawal before age 59 1/2.
  • Education IRAs. Because the proceeds from this type of an IRA must be used for a particular purpose (qualified tuition expenses), you should keep records of all expenditures made until the account is depleted (prior to the holder's 30th birthday). Any expenditures not deemed by the IRS to be qualified expenses will be taxable to the holder.

Investments. Brokerage firm statements, stock purchase and sales confirmations, and dividend reinvestment statements are examples of documents you should keep to verify the cost basis in your securities. If you have securities that you acquired from an inheritance or a gift, it is important to keep documentation of your cost basis. For gifts, this would include any records that support the cost basis of the securities when they were held by the person who gave you the gift. For inherited securities, you will want a copy of any estate or trust returns that were filed.

Keep in mind that there are also many nontax reasons to keep tax and financial records, such as for insurance, home/personal loan, or financial planning purposes. The decision to keep financial records should be made after all factors, including nontax factors, have been considered.